Monday, August 27, 2007

The headline used by the mass media, burdened with an insatiable need to oversimplify everything they touch:

New-home sales rise 2.8% to 870,000 pace in July

Reason number 5 you should ignore the headline - a very tricky formula or how statistics can lie.Months' Supply

The months' supply is the ratio of houses for sale to houses sold. This statistic provides an indication of the size of the for sale inventory in relation to the number of houses currently being sold. The months' supply indicates how long the current for sale inventory would last given the current sales rate if no additional new houses were built.

Investors love this formula, but it can shift suddenly if there is a sudden move in either part of the formula.

The numerator is houses for sale, while the denominator is houses sold. The government reported that in July 2007, the months' supply was at 7.5 months based on a seasonably adjusted annual rate. This translates to 533,000 homes for sale and 71,000 homes sold.

The severe contraction in residential mortgage credit has been underway all summer, but reached its peak in earnest in August. Now when August sales are reported next month, the numbers will show the effect of that contraction. look for the numerator to rise sharply as unsold homes pile up, and the denominator to fall as many sales fell through due to unavailability of credit.

A 10% move up in the numerator, and a 10% decline in the denominator would cause the months' supply to rise to 9.17. A 20% move would result in a months' supply number of 11.25. the 9.17 number would be the highest since 9.4 in January 1991, while 11.25 would be the highest since September 1981. The highest ever recorded was 11.6 in April 1980.

There may be some shenanigans going on with this data as homes for sale, seasonally adjusted, has been remarkably stable the last year.